September 2023 returns review
September was a little rough for global investors. In aggregate, global equities fell through the month, with the US and Europe as its largest constituent declining. UK, Japan and Emerging Markets (EM) on the other hand finished mildly stronger.
It marked the end of a dreary third quarter, during which markets slumped and economic risks became more salient. Last month’s themes were largely what they have been since July: weakening global trade, an oil supply crunch (and hence higher prices), unrelenting central bank pressure and a strengthening dollar. Bonds continue to be under pressure despite the already much higher yields that now come with holding them. The table below shows sterling returns across various different regions and asset classes:
Asset class returns as at 30th September 2023
As the table shows, headline returns for UK investors do not look too bad: global stocks are only slightly down in sterling terms, and the FTSE 100 actually gained on the month. But this hides significant currency volatility. Sterling lost nearly 4% of its value against the dollar in September and fell noticeably against an already weakened euro. Weakness in the UK economy, a perceived softening of the Bank of England’s stance and overvalued terms of trade (as we have covered before) weighed against our currency for the entire quarter. The pound reached a high of $1.31 in mid-July, but this has come down to $1.21 at the time of writing. As has often been the case in recent years, though, a weaker currency helped the largely multinational FTSE 100, where revenues arise in currencies other than the pound.
The index, home to several energy companies, also benefitted from sharp rises in the price of oil. International benchmark Brent Crude climbed 10.2% in sterling terms last month, rounding off a phenomenal quarter which ended with crude prices 27.4% higher. Brent broke $90 per barrel in early September and only closed lower in early October. It was oil’s strongest quarter since Q1 2022, when Russia’s invasion of Ukraine upended global energy markets.
Naturally, the spike in oil resurfaced inflation concerns – coinciding with some aggressive central bank messaging and a significant increase in bond yields. As we commented recently, though, the longer-term effect of oil’s rise might actually be disinflationary as it acts as another headwind to economic activity. Brent’s rally is very clearly the result of supply constraints from Russia and Saudi Arabia, as overall global demand remains weak. We can see this in the performance of wider commodity prices, some of which (like metals) have been noticeably poor. In these situations, higher oil prices usually act as a tax on consumers and non-energy businesses, rather than a spur for further price increases. That is likely to mean constrained growth – and hence less pressure on prices – over the medium term.
That being said, bond markets have certainly not acted like inflation concerns are fading. Bond prices took a further step down in September, and indeed through all of Q3, as yields rose up to decade highs. US 10-year Treasury yields ended last month at nearly 4.6%, levels not seen since 2007. Japanese Government Bond yields nearly doubled to their highest point since 2013, while German Bunds topped 2.8%, a yield it last reached in 2011. Indeed, the bond sell-off was the main reason equities fared so miserably, with valuations moving down thanks to the sharp increase in ‘risk free’ rates. The mechanical effect of bond yields on equities is probably why the latter fell in almost a straight line – simply drifting lower as risk valuations adjusted, while earnings expectations remained broadly unchanged.
Bond markets were seen as – and perhaps still are – adjusting to the ‘higher for longer’ edict from central banks. Central bankers have long pushed the line that interest rates need to stay high to curtail structural inflation pressures, but it seems only in the last few months have professional bond investors and traders started believing them. The US Federal Reserve (Fed) signalled it would cut rates much more slowly than investors had priced in, catching out and sometimes forcing to unwind position those who had thought the cyclical high in bond yields had been reached early in the summer. This market repositioning is likely what pushed long bonds up to 4.7% at the time of writing.
The US economy in the meantime continues to be impressively resilient. Growth has clearly slowed and the labour market has now finally cooled, but outright contraction looks unlikely in the short-term and headline inflation was rising again. With its rate rise pause, the Fed is essentially predicting a ‘soft landing’ for the US economy, meaning it can stop hiking rates but has no near-term need to cut them. The Fed’s dots plot – a graph of where different policymakers expect interest rates to be out into the future – now shows a significantly shallowed decline over the next two years. The chasm between these expectations and those previously implied by bond markets corrected over Q3, and investors on the wrong side of this dynamic have paid the price.
Central bank guidance was not the only thing preoccupying bond traders, though. In August, ratings agency Fitch downgraded its rating of US Treasury bonds, depriving the US of its last remaining AAA rating. These events rarely have a direct impact on bond markets, but it was a timely reminder of America’s deteriorating fiscal position. Last month, the Fed’s tighter monetary stance was exacerbated by an avalanche of Treasury bond issuance. The received view among bond analysts is that the US is on a long-term trend toward debt expansion – starting with former President Trump and accelerating under President Biden.
Importantly, these bond market adjustments have not come at the expense of expected long-term growth prospects. Indeed, relative to other major economies, the US remains one of the safest bets for long-term earnings growth – particularly in light of its concentration of AI-related tech companies. With rates of return now tilted more heavily toward the US, this has caused the dollar to swell in value against global currencies. This is because of US stability – but the effect on the rest of the world will likely be instability. A stronger US dollar brings risks for markets and the non-US economy, regardless of why it comes about.
The text is taken from The Tatton Weekly and is provided by Tatton Investment Management. The information in this document does not constitute investment advice or a recommendation for any product and investment decisions should not be made on the basis of it.
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